微晶片科技 (MCHP) 2008 Q2 法說會逐字稿

Good day everyone and welcome to this Microchip Technology second quarter fiscal year 2008 financial results conference call.

As a reminder, today's call is being recorded.

At this time I would like to turn the call over to Microchip's Chief Financial Officer, Mr.

Gordon Parnell.

Please go ahead, sir.

Thanks, Matthew and good afternoon everybody.

During the course of this conference call, we will be making projections and other forward-looking statements regarding the future events or the future financial performance of the Company.

We wish to caution you that such statements are predictions, and that actual events or results may differ materially.

We refer you to our press release of today as well as our 10-K for the fiscal year ended March 31, 2007, and our 8-K current reports that we have filed with the SEC that identify importance risk factors that may impact Microchip's business and results of operations.

In attendance with me today are Steve Sanghi, Microchip's President and CEO and Ganesh Moorthy, Executive Vice President.

I will comment on our second quarter performance, reviewing geographic data and discussing balance sheet and cash information, and Steve and Ganesh will then give their comments on the results, outline our guidance for the December quarter and update other pertinent matters regarding our business.

We will then all be available to respond to specific investor and analyst questions.

So let's get going with the net sales review for September.

They were $258.6 million, down approximately 2.1% from net sales of $264.1 million in the immediately preceding quarter, and down approximately 3.5% from net sales of $267.9 million in the prior year second quarter.

From an earnings perspective, we are continuing to include some additional information in our press release related to FAS 123R.

Our non-GAAP results exclude the affect of the adoption of this accounting standard and in the September quarter, the financial impact of the sale of Fab 3 in Puyallup, Washington.

Non-GAAP net income for the September quarter was $83.3 million, or $0.38 per diluted share, a decrease of 3.9% from non-GAAP net income of $86.7 million, or $0.39 per diluted share in the immediately preceding quarter and a decrease of 1% from non-GAAP net income of $84.2 million, or $0.38 per share in the prior year second quarter.

We completed the sale of Fab 3 in Puyallup, Washington on October 19, based on the initial sale and purchase agreement that was entered into during the September quarter.

The sale proceeds from the transaction were $30 million.

Based on the net book value of the facility and normal costs associated with the sale of the property, the sale resulted in a pretax loss of $26.8 million.

The impact on earnings net of tax was $0.074.

GAAP net income for the September quarter was $60.7 million, or $0.27 per diluted share, inclusive of all share based compensation expenses and the sale of the Fab 3 in Washington, I just mentioned.

The impact on earnings related to the adoption of share based compensation in the September quarter was 7.4%.

Let's take a look at our geographic information.

Both the Americas and Europe were down sequentially while Asia was essentially flat.

Americas was down 0.7% sequentially, and was impacted by the economic conditions that we discussed and indicated in our preannouncement on October 8.

Our results in Asia were similarly impacted from our initial expectations.

Europe net sales were impacted by the seasonal effects of business closures in the summer period in southern Europe mainly with net sales being down 5.8% sequentially.

Asia continues to be our largest geography representing approximately 44% of total sales.

Europe was approximately 29% of sales, and the Americas were approximately 27% of sales.

This measurement is based on where the product is delivered for manufacturing purposes for our customers, but doesn't necessarily represent where the design activity is taking place, or where the consumption is occurring.

Looking at operating information, initially I'm using gross margin and operating expenses information prior to the effects of share based compensation, and also excluding the effects of the sale of FAB 3 for this initial discussion.

Gross margins were 60.4% in the September quarter, close to our all-time high levels of the previous quarter.

The sale at Puyallup will have a positive impact on gross margins in future periods, adding approximately 50 to 60 basis points to gross margins.

Operating expenses were 25.5% of sales in the September quarter, essentially flat with the prior quarter, which were 25.4% of sales.

Research and Development costs were $26.8 million, representing 10.4% of sales.

Sales and general administrative expenses were $39.2 million, representing 15.1% of sales.

And on a full-GAAP basis, gross margins including the share based compensation were 59.8%.

Research and Development expenses and SG&A expenses combined were $72.3 million, or 27.9% of sales.

The tax rate for the September quarter was 20.4%.

Our tax rate is impacted by the mix of geographical profits and the percentage of our cash that is invested in tax advantaged securities.

The tax rate for the December quarter on a GAAP basis will include a favorable settlement of a foreign tax matter of $5.7 million.

Otherwise, the underlying tax rate is similar to that of the September period.

The dividend declared today of $0.31 per share was an increase of approximately 5.1% sequentially, and an increase of 24% over the same quarter in fiscal 2007.

The dividend payment to be made in the December quarter will be approximately $67 million.

Turning to the balance sheet, Microchip's inventory increased approximately $800,000 to $124.6 million in the September period, and it now represents approximately 109 days of inventory.

On the distribution side, our deferred income on shipments to distributors grew by about $3.5 million, quarter-over-quarter.

At September 30, distributors were holding about 1.9 months of inventory based on sell-through.

Combining inventories on our balance sheet and at the distributors, they would represent approximately 142 days of total inventory.

Combining both elements would increase by about 4 days from the prior quarter.

Microchip's receivables at September 30 were $125.9 million, a decrease of $1.4 million, or about 1% from the balances at the end of June.

Payment performance by our customers continues to be in excellent shape with minimum balances beyond acceptable terms.

On the cash position at September 30, Microchip had approximately $1.249 billion on the balance sheet at the close of the quarter.

During the quarter, Microchip generated net cash flow from the business of $119.6 million.

Payments related to our cash dividend of $0.295 during the quarter were $64.1 million, and the cash used related to our buyback of 4 million shares was approximately $150.2 million.

We anticipate building approximately $100 million in operational cash in the December quarter, excluding the cash received from the sale of Fab 3.

And we have purchased 900,000 shares in the current quarter in open market transactions using cash from treasury in the amount of $28.6 million.

Our capital spending for the September period was $11.7 million.

Depreciation expense for the September quarter was $25.4 million, versus $29.2 million in the same quarter last fiscal year, and $26.4 million in the June quarter.

Our capital forecast for fiscal '08 is currently 60 to $65 million, and depreciation forecast is approximately $100 million, again for the full fiscal year.

Now I'll ask Steve and Ganesh to discuss the performance of our business, our guidance for the December quarter and update other business matters.

Ganesh?

Thank you, Gordon, and good afternoon, everyone.

I will now comment on the individual product lines after which Steve will walk you through our guidance for the next quarter.

Our Microcontroller business was down just over 3.5% sequentially, and was down just over 4% from the year-ago quarter.

While we're disappointed with these results, we believe they are reflective of a weak market environment, and that our microcontroller product line and market position remain very strong.

Our Flash Microcontroller business was up almost 1% sequentially, and up 3.5% over the year-ago quarter and now represent over 72% of our Microcontroller business.

So the drop in revenue in the September quarter came entirely from our older one-time programmable products, many of which are designed into legacy end products built for the housing and consumer markets.

Our new product development for over 5 years has almost exclusively been Flash based Microcontrollers.

Looking at our leading indicator, which is new development tools shipped, we shipped 26,344 development tools last quarter.

This was our second highest quarterly shipments ever, demonstrating the continued strong design win activity and acceptance of our products.

Moving to 16-bit microcontrollers, we grew-- we were up over 6% sequentially, and up 84% over the year-ago quarter.

Despite the headwinds in our overall business, we were able to achieve another quarter of good sequential growth, and expect to post double-digit growth in the September quarter.

16-bit design win momentum and development tool sales remain very strong.

We shipped 5,059 16-bit development tools in the September quarter, the second highest quarterly shipments of development tools for 16-bit ever.

This brings the total 16-bit development tools shipped to date to 36,776.

Significantly, the number of 16-bit development tools shipped in the first 6 months of fiscal year '08 was almost 3 times the number shipped in the first 6 months of fiscal year '07.

During the quarter, we also release 9 more 16-bit products to production, bringing the total number of products in production now to 101, and we expect to have approximately 150 products in production by the end of fiscal year '08.

The number of volume 16-bit customers grew to 1,018 in the September quarter up from 897 in the June quarter, and in terms of 16-bit customers of all volumes, that number remains in the several thousands.

Moving to our analog products, our analog business was flat sequentially, and down just under 3% from the year-ago quarter.

Our analog products are designed into many of the applications that our microcontrollers are designed into, and experienced some of the same headwind we saw in our Microcontroller business.

The number of customers buying our analog products grew to 12,833, from 12,627 in the previous quarter.

Our serial E-squared memory business was up over 7.5% sequentially, and was up over 1.5% from the year-ago quarter.

Sales were helped by strength in the PC market segment, as well as normal seasonality in this business segment.

Pricing declined moderately quarter-over-quarter.

Now let me pass it to Steve for some general comments as well as our guidance for the September quarter.

Steve?

Thank you, Ganesh, and good afternoon, everyone.

Today I would like to first reflect on the results of the September quarter, then I will discuss the thinking behind the sale of Fab 3, and the resulting capacity available to Microchip.

Then I will provide guidance for the December 2007 quarter.

We experienced very challenging industry conditions during the quarter that led us to lower our guidance in the pre-announcement of October 8.

I am disappointed that conditions in the U.S.

housing market have continued to deteriorate, and some of the effects of credit crunch have filtered into our consumer segment outside of housing.

We have seen this through the weakness in our Asian business related to U.S.

multinationals who do manufacturing at Asian subcontractors.

This has resulted in sequentially down revenue for Microchip.

I am disappointed by the market reaction to our pre-announcement on October 8, and I would have thought that the credibility that we have established over many years would have stood for more in the face of difficult business conditions.

I'm confident that future results of Microchip will vindicate us and regain investors' confidence.

One of the main questions in the investor's mind is, is Microchip losing market share?

That question is not any different than the one we have fielded at other occasions in the past when we missed a quarter because of a significant disruption in the marketplace.

Other such events were the Asian financial crisis in 1998, the SARS epidemic in 2003, the inventory correction of 2004 and the military coup in Thailand affecting our operations in 2006.

At each of these occasions, the investors' first reaction was that market dynamics had changed, and Microchip was losing market share.

Yet a quarter or so later, all the other companies felt the same issues, and we showed that we continued to gain market share.

Some of this data is already beginning to appear.

For example, Arrow Electronics, the second largest component distributor, this morning guided their components revenue to be down between zero and 7.5% for the December quarter.

With Arrow as a proxy for the semiconductor industry, you will see this effect in many companies' results.

Freescale just announced the results and their TSGP Group where microcontrollers are housed was down 4.5% sequentially.

Altera also just announced their results.

They missed their guidance, too.

They were down 1% sequentially and guided down zero to 4%.

Xilinx was also flat sequentially and guided down 5%.

Both Altera and Xilinx recognize revenue at sell-through from distribution just like Microchip does.

I saw some hints of softness in Texas Instruments' numbers, too.

However, their sell-in revenue recognition cushions their results a bit, so we are also starting to get some correlation with sell-in versus sell through revenue recognition companies.

Now, in the past, at such occasions investors also felt that Microchip's gross margin was not sustainable.

As we have shown, our gross margin has continued to hit new highs after each of these events.

At each of these events, our inventory also rose and investors felt that an inventory write off was coming, yet Microchip did not write off inventory, because the life cycle of our products is very long.

We are facing one of those events again.

There is plenty of data around.

Housing starts have been cut in half.

All the companies exposed to this sector, homebuilders, lenders, transportation companies and others, are feeling the pinch.

We have detailed the impact on Microchip through a U.S.

housing index, as well as examples of several customers on a no name basis that were down 17%, 20%, and 26% sequentially.

We have also shared the data from Appliance Design Magazine, showing how far some of the end applications are, like air conditioners, heat pumps, furnaces, residential water heaters, and cooking equipment, and now with data coming Arrow, Arrow Electronics, Freescale, Altera and Xilinx, it points to the economic softness spilling over in other segments, also.

So in spite of these challenging conditions, we will continue to focus on our business, and continue to make improvements so that as the housing and consumer sectors stabilize, we see strong growth in our business.

So let me give you an update on some of the things that we're doing.

First, the sale of Fab 3 was a culmination of several factors coming together.

Fab 3 was not listed for sale, although some of the excess land around Fab 3 was for sale.

We received an unsolicited offer for the whole site.

Secondly, we are qualifying a new proprietary technology in Fab 4 that significantly extends the available capacity in our two fabs.

So we now believe that our current equipment set will take us to $1.6 billion of revenue with nominal capital equipment additions.

And with further equipment additions in Fab 4, and some in Fab 2, we can take the total capacity in our two fabs to $2.2 billion.

Thirdly, we are having good success in producing several of our products in foundries.

We believe that the capacity available from the foundries will take our available capacity to $2.5 billion and beyond.

Therefore, as we received this unsolicited offer on Fab 3, we believe that we will not be using Fab 3 for many years into the future.

In addition with many leading edge technology companies going to 300 millimeter, a large number of 200 millimeter fabs, fully loaded with equipment, will become available to purchase at very economic prices in the future.

Therefore, we decided to close the sales transaction on Fab 3.

The result will be a 60 basis points improvement in our gross margin, and about $27.5 million additional cash in our treasury.

Number 2, we are continuing to introduce new 16-bit microcontrollers at a rapid pace.

We have significant momentum on this product line.

Despite significant headwinds we were up over 6% sequentially, and up over 84% over a year-ago quarter, and we expect double-digit growth in 16-bit microcontrollers in the December quarter.

Number 3, despite short-term revenue and earnings compression, we are continuing to increase dividend paid to the investors.

At the current dividend rate and the stock price, the dividend is about 4%.

And number 4, we have said for some time that our stock buyback plan is opportunistic.

We purchase stock when we think that the investors no longer understand the story, and have thrown the baby with the bath water.

We believe that now is such a time.

Therefore, we have been aggressively buying back stock which Gordon has detailed for you.

Now let me provide you guidance for the December quarter.

Our book-to-bill ratio for September quarter was approximately 0.94.

The December quarter is also a seasonally weak quarter for Microchip.

With customers in housing and consumer segments uncertain about their businesses, we expect many customers to take longer vacations and schedule shut down days over the holidays.

Therefore, we expect our December quarter will be down sequentially.

Because of the level of uncertainty we are providing a wider range of guidance than normal.

We expect our net sales to be down between zero to 6% sequentially.

We expect to achieve record gross margin of 60.8 to 61.1% on a non-GAAP basis, and our non-GAAP EPS is expected to be $0.35 to $0.38.

With that, Matthew, would you please poll for questions?

Thank you.

(OPERATOR INSTRUCTIONS) Our first question comes from Romit Shah with Lehman Brothers.

Thanks.

Steve, you provided fairly wide guidance for the December period.

Could you just run through some of the swing factors that could get you either to the high end of the guidance or to the low end of guidance?

Well, Romit, swing factors, really our customers' behavior.

We have seen in prior cycles, where when the customers' businesses are soft, many of them have year-ends, fiscal year-ends and when the business are soft they use the holidays to take extended shutdowns.

Or, close down the operations, or trim their operating plans.

And we're hearing some of that in our conversations with the larger customers, but those plans are not firm.

And we have seen in the last quarter some of the customers we met, and they told us what they were going to buy in the quarter.

Many of them were down significant to that expectation.

So customers don't know themselves in this time frame what they're going to do, because they are relying on their businesses doing better, and their end customers buying.

And when the segment confidence in the housing, consumer and other segments continues to slip, and you are starting to see that happening now in some of the other segments, seen through Arrow and Altera and Xilinx's announcements -- which were not available at the time of our preannouncement and many investors felt that we had a stand-alone problem -- you can now start to see there is some company there.

So we believe our customers don't know, and it will really depend on customers' plans and behavior really where those numbers will come out.

Our second question comes from Chris Danely with JPMorgan.

Thanks, Steve.

Hey, Steve, now that we're sort of working our way through this thing, how do you compare this -- this downturn or correction versus the previous problems we've had?

I guess the reason I ask is that assuming that the December quarter is down, that would be three out of five quarters with negative growth, and I think the only other time that happened was the tech bust.

So if you could just take a step back and compare this time right now versus the previous downturns.

Well, the -- the tech bust was driven by PC and communications sector, and this particular bust, at least for us, was driven by housing and consumer segment.

But during the tech bust, an average PC communication company was down 50 to 90% in revenue, and in this segment we are seeing the people in the housing and consumer segment down 20, 40, 50%, although not as much down as in the tech bust.

Now, if the Company was exclusively exposed to that segment alone, then we'll be down as much as some of the homebuilders are.

You know, 50, 60, 70%.

We were -- we are actually up year-to-date if you look at the numbers.

We were up 3% in March, and then we were up 2% in June, and we were down 2% in September.

So year-to-date, we're still up 3%.

That is what diversification is doing.

We're exposed to many different sectors, and so diversification does work, but when a single segment is not just soft, goes down 4 or 5%, it's busted, it's down 50%.

At that point in time, with significant exposure to that segment, some of the numbers we have posted I think they're unavoidable.

But the numbers do show that the diversification does work.

And I can't imagine a company in the PC and Communications sector, if their sectors were down 50%, those companies will be down similar.

And we are up 3% year-to-date.

So take it either way you like.

And our next question comes from Simona Jankowski with Goldman Sachs.

Thanks very much.

Steve, just curious if you can update us on your book-to-bill.

I know it's not always a good predictor, but you did say it was about 0.94 at the time of your preannouncement.

If we were just to kind of flat line that, it would imply a minus 6% guidance at the midpoint.

So I'm just wondering if you have either seen an acceleration since your preannouncement or if you are expecting one, to give a guidance range that's a little bit above that kind of a midpoint.

Simona, well, you may remember from dozens of conference calls, our book-to-bill never correlates to the end revenue we achieve, it never has.

There are a number of times when book-to-bill is 1 and we achieve significant sequential growth; and when the book-to-bill is less than 1 and we do better, much better than that.

So we have never found a good correlation between book-to-bill and actual numbers, so --

So suffice it to say, though, we shouldn't read your guidance as you having seen some kind of improvement or acceleration in the trends you had talked about a month ago?

No, I -- my notes, or any of my colleagues' notes didn't point to any change in business.

We were down 2%, and we're guiding down 3% at the middle point, zero to minus 6%, so we don't want you to read anything other than what we guided.

Sure.

Then I definitely agree with what you're saying about pointing to Arrow and Altera and some of the other negative earnings reports coming out of Semis.

I did want to ask you though about a couple of specific comments made by some of the other component suppliers.

One was from Fairchild who actually pointed to pretty positive trends in their white goods business; and then TI's microcontroller business specifically was pretty stable.

Just curious if you can contrast for us maybe the trends and exposure you have versus those particular competitors.

Well, this is another phenomenon we have seen at a number of these events, and I highlighted a little bit of that in my commentary.

Fairchild, TI, both of these companies recognize revenue at sell-in, while Microchip recognizes revenue purely at sell-through worldwide.

And we have seen numerous time the ability it gives the companies to manage their revenue in a sell-in situation by simply asking distributors to take a little more inventory.

If you were to take our inventory build at the distributors last quarter, if we had recognized that for revenue, then our results would be better, too.

And we have seen many of these companies that just fall harder because you can't really build that inventory forever when the distribution corrects it in the face of weakening conditions.

So Arrow guiding zero to minus 7.5, what do you think they'll be doing with their inventory?

You will see that result spill over to all these companies who are sell-in revenue recognition companies.

We have seen this music so many times, that I'm reasonably confident that you will see that and you are starting to see it already.

Sure, that's fair.

And then just last quick question is on inventory at your end customers.

One of the trends I like to track is the microcontroller shipments relative to the long-term trend line, and we have seen a pretty significant divergence in the last few quarters, where microcontrollers are well above the long-term trend line.

We often look at that as an indication of inventory build at the end customers.

So, just curious if you have any way of checking your -- I know you have a lot of fragmented and small customers.

But do you have sense of whether some of their reduction in their orders and forecasts are a result of them reducing their own inventory in addition to their demand weakening?

Ganesh, do you have any sense of that?

My sense that customers never really know, and it's very difficult to discern softness as business versus changes in an inventory position.

As best as we can tell, they don't tell us they're decreasing their inventories.

We know that they are building less and that's why we see less orders on us.

Okay.

Thank you very much.

Simona, I would add that softer build rates at the customers and inventory reduction is really tied at the head.

Anytime a customer starts building less because of weaker demand for their end customers, the first impact they see is they find higher raw material inventory based on what they have to build.

So, part of the reduction always is the inventory correction, because their end product demand is weak.

So I've not been able to separate them in the past, and I believe they're really joined at the hip.

Okay.

Thank you.

You're welcome.

We have a follow-up from Romit Shah with Lehman Brothers.

Steve, Arrow talked about Europe slowing down or not coming back in September and that trend pretty much continuing through October.

That was the one region that came in line with your expectations.

Are you expecting Europe to grow in the fourth quarter, or would you expect it to be down with the other regions?

We have -- we are usually fairly cautious on Europe every summer, because of the European holidays.

We have seen that so many times that we usually do not count on Europe really to be up in the summer quarter.

So even though Europe was down 5.8%, which was more down than any other geography around the world, we simply said that we counted on that Europe is always down.

So Europe was quite weak.

As far as December quarter is concerned, we haven't broken it down, but I don't believe we're counting on Europe to be up in December.

I think Europe tends to have, as it gets into middle of December, a lot higher percentage of our customers and our distributors (technical difficulty) more extended normal seasonal vacation time.

So that's a factor that we're considering here also.

Okay.

And if I could just lastly, does your long-term gross margin target change with the sale of the fab?

No, it really does not, because in our long-term target, we kind of counting on either using it or selling it.

And we no longer believe that we are going to use it for many years because we have figured out a way to extend existing fabs much longer based on the numbers you have heard before in terms of what the capacity was.

That number is a lot higher today, based on a lot of the things we have done in technology.

So our long-term target, no, it does not change.

Okay.

Appreciate the color.

Thank you.

You're welcome.

And we have a follow-up from Chris Danely with JPMorgan.

Thanks, guys.

Can you hear me?

I'll go ahead.

Your line is open.

Okay.

Great.

Just making sure you could hear me.

Steve, do you expect the OTP microcontrollers to continue to trend down?

Can you give us a sense of what you think is going to happen to that part of your business going forward

The OTP microcontrollers have been kind of trending down slowly for a long time, because even though the life cycle of our products is very long, after 5 years of not adding any products in it you eventually have them roll off.

But growth of the Flash microcontrollers has been making it up quite significantly.

Last quarter, we sequentially grew only 1% in Flash microcontrollers, because of challenging business conditions, so we did not override the decline of OTP.

And the decline of OTP was also more severe because some of these products were in older models and older legacy products, where that's where the customers correct when they're not building enough product.

So we will expect OTP to continue to decline but not certainly at the pace we saw last quarter.

Sure.

And you've always maintained that you would rather keep your margins than chase after these sort of higher-volume lower-margin opportunities.

So if you were given the choice, and things start to get a little bit more competitive, would you rather lose some share in certain areas of microcontrollers and keep your margins high?

Or would you choose to -- if it would impact your growth rate, would you choose to maybe get a little bit more aggressive on pricing and sacrifice a little bit on the margin side?

I have not faced that situation in the microcontroller business in 15 years.

I don't expect that would happen.

We will continue to gain market share with excellent gross margins.

So I don't need to look at the hypothetical, because I don't think that will happen.

We have always said we have got many levers in the gross margin side, and we have always talked about using some of those cost advantages back at the marketplace to make it more uncomfortable for competitors.

And that's what we've been dealing with for years, and so that doesn't really change.

Okay.

And that leads to my last question.

Now that you guys have given guidance, if you look at the total years, 2006 and 2007, one of your bigger competitors in 8-bit, Atmel, has roughly doubled your growth rates.

So what gives you confidence that you are not losing share to them?

Well, the -- the share is calculated as a share of the overall market.

If you look at, 1 year, 2 years, 5 years, 10 years, or any period of time, we have substantially outgrown the market.

The numbers I have looked at from 2001 to today, we have outgrown Atmel in 8-bit micro.

Now, you could really pick a different time frame, pick a year, or two year, or any period in time, and one company or the other company could come on top.

But we are -- you lose share when you are growing less than the market.

We have never grown less than the market.

Okay.

Thanks.

The -- the other thing I would say, Chris, is that the general feedback we've receiving from investors and some of the analysts commentary is that somehow there are tremendous market pressures on us.

Your gross margin question hinted towards tremendous pressure that we somehow crash on ASPs or something like that.

We like to show you that we are not seeing any of that.

Our business is stable, it's good, other than the issues we have identified in consumer and other markets.

Gross margin last quarter was excellent.

We expect it to go higher this quarter.

We're able to handle the normal decline in ASP's and all that we're seeing through the normal avenues we have available of cost reduction, yields, new technologies, depreciation rolling off, and all the additional benefit of really not paying for the Fab 3 sitting idle.

So I would like to really put your concern to rest that we're not seized by the market forces of Atmel or anybody else.

I would like to put my concerns to rest, too.

I wish there was more I could help you with.

Moving on, we will hear from Craig Ellis with Citi Investment Research.

Thanks for taking my question.

This is Ken So calling in for Craig Ellis.

Steve, when I look at the overall annual growth rate from fiscal '03 to fiscal '07, it is around 12%.

I'd expect it to be flat for fiscal '08.

How should we think about the R&D intensity if you want to get back to that level of growth rate?

And also is that same type of growth rate still a reasonable level to expect going forward?

I'm sorry, I'm have not been able to figure out an accurate growth rate that I would like in the last one or two quarters.

You're asking me to project it years out.

I really have no ability to do that.

Okay.

Then maybe switching gears a little bit, when I look at the sequential growth in analog, it's slowed quite a bit over the past six quarters, or so, based on our model.

Should we expect to see some return to previous growth rates within analog despite some of the near-term headwinds?

Or does there need to be a small acquisition to support that level of growth that we saw in fiscal '06?

I think that's a good question, analog is a good question and something we are pondering over ourselves.

I think the growth in analog we have found challenging.

We've had reasonably good years.

Last year was a good year.

We were up 24%.

We grew the year before.

However, starting from the inventory correction that happened in the December quarter, most analog companies were down.

Most analog companies were down even in the March quarter.

I think we saw significant issues with our analog, also.

And our analog business is also somewhat tied to really where we sell our microcontrollers, because a lot of it is selling to the same customers.

So our analog exposure is also somewhat like our microcontroller exposure in similar segments, so that has been hit by housing and consumers and those kind of things, also.

So having said all that, I would accept that we are finding the growth in analog challenging.

And we are internally looking at ways to really boost that.

Okay.

Thank you.

Moving on we will hear from Jeff Rosenberg with William Blair.

Hi.

Steve, could you elaborate a little bit on your use of foundries?

How much of your business, have you increased the amount of opportunity you see in the outsource manufacturing, and what sorts of products are you thinking make sense to go that way?

Well, I don't know if I can give that detail, but one question you asked is how much of our business is foundries today.

It's fairly small.

It's under 5%.

But the key question in the foundries for Microchip has been, since we have not historically used foundry, can we be successful at that model?

Can we successfully develop products, can we add enough of our own IP to make the resulting products come out at a gross margin which could meet the Microchip model, rather than, since the foundries make gross margin, would that substantially lower our model?

We have worked through those challenges and have found that we can successfully develop products, analog and microcontrollers and other, basically products in all different segments where it will cost a significant process development inside Microchip, substantial R&D investment inside Microchip to develop those products inside Microchip.

We have now found that we can take these relatively smaller business plans and since we don't have to develop the technology portion of the R&D, we can go to foundries.

We can actually build an equally successful model with them as we are achieving with our overall business.

So there are a good number of products which have been designed, which have been released to production.

They're ramping.

So our foundry portion of the business is growing, and we think in the next five years, it could be 10% higher, depending on the success of those products.

So I think that's the difference.

Okay.

And then a second question on inventories with that looking like it's tracking to about 120 days this quarter.

Can you give us some feel for what level of revenue you need to get back to before you feel like you can start to bring that down, and how we should think of that relative to what it means for your gross margin over the next few quarters?

Gordon?

I think the sort of breakeven position is about $260million-ish a quarter, in terms of inventory.

So, below that, we're going to add somewhat to our inventory, inventory balances at this point.

Okay.

Thanks.

And moving on, we will hear from Gil Alexander with [Garfield] Associates.

Good evening.

Steve, could you give us some guidance at this point as to the dollar sale of your 16-bit, or you would rather hold off at this point?

Gil, I would rather hold off.

That's fine.

Thank you.

I think it seems to be very competitive information which somebody will pay money to get that.

Fair enough.

Thank you.

Appreciate it.

And our next question comes from Kevin Cassidy with Thomas Weisel Partners.

Thank you for taking my question.

A lot of my questions have been asked, but is the -- who bought the Fab 3?

Can you say that?

It was sold to a developer, essentially, who is going to do something with the excess land, something with the building, and something else with the fab.

So it was really not a semiconductor manufacturer.

So the fab will be taken out commission.

Has been out of commission for many years.

It was just an empty shell.

We don't really know what the purchaser will do with the site.

Okay.

Thank you.

And moving on we will hear from Kevin Rottinghaus with Cleveland Research.

Thanks.

Could you kind of give us any indications on maybe the strength that you are seeing in the memory markets, what that is attributable.

Is it all just end market based or is something else going on?

Your question was about the memory market?

Yes.

Memory always has a seasonally strong September quarter, so some of the strength we saw last quarter was attributable to that.

And as you've seen, we have memory sales that go into some of the office automation market, and we saw some of the strength in that segment reflected in the memory business as well.

So those are the two combination of factors in last quarter's memory results.

Okay.

With, I guess, forecast for continued strength in PCs, would you expect that segment to continue to track well for the December quarter?

There's various factors, so segment strength is only one.

There are other seasonality factors, and memory usually has seasonal weakness as it goes into the December quarter, based on other market segments that it sells into as well.

Okay.

How about the percentage of revenues through distribution this quarter?

It's about 64%, 65%, so not a whole --

Stay the same?

Yes.

Then any changes on headcount, or could you give us any kind of update on headcount since the last K?

There's no real significant change in terms of overall headcount for the business at this point in time.

Factories are flat, sales force is built, divisions are well staffed.

There are minor changes here and there, any replacements if somebody leaves or minor adds here and there.

But under such business conditions, we're really not growing headcount anyway.

Just last question for me.

Just strategically, has there -- do you have any thoughts kind of on the need to be more involved in kind of the 32-bit market, or are you kind of comfortable with the product portfolio as it is, thinking either near-term or long-term?

Well, we are -- we are a microcontroller supplier, and when we used to get that question in -- on 16-bit, we couldn't answer it similarly, because we don't want to give a hint to any of the competitors what we might do in the future.

But eventually we did the 16-bit, and the natural result is we will eventually do the 32-bit, but we can't give a hint of when we might need it.

Our products today, the dsPIC, and PIC 24 16-bit products, are extremely competitive in the 16-bit world.

Our 16-bit architecture, which actually is 24-bit wide inside and 16-bit on the output side, it's 50% faster in performance compared to an RM7, which is 32-bit architecture.

So we have a powerful architecture.

We are winning share.

We compete with 32-bit microcontrollers every day with our 16-bit, and come out winning a lot of times.

Okay.

Thank you.

(OPERATOR INSTRUCTIONS) Moving on, we'll hear from John Pitzer with Credit Suisse.

Thanks, this is Amit calling in for John.

Just outside of the consumer industry in 3Q, or the consumer end market, do you believe you saw any unusual strength that might have offset the consumer weakness?

Or even in the early days of Q4 here was there any unusual activity in any of your other end markets?

I think there's nothing particularly that's stands out.

I think some of the segments that have seasonal strength in the third quarter, we saw strength, too.

So you've seen companies that are PC exposure who have seen some of the strength there.

We had similar strength in that segment in the third quarter, but nothing out of the ordinary I would call out.

Okay.

And then my general answer really would be that we're a horizontally structured company that sells to 58,000 customers around the world, and we are really usually not segment focused.

Unlike many companies who are organized by the end market segments and build special products for end segments, we do no special products for consumer segment or communication segment, or PC segment.

Our products are standard catalog kind of products that go horizontally across many markets, so most times we don't really know where we're selling because we're not organized and sold that way.

65% of our business is really through distribution, and a lot of times we don't really know where it is going.

We -- we have provided you some special inside look on this housing segment.

That required a lot of work, and painstakingly we created an index for you to give you insight as that sector was sort of getting busted.

But that doesn't translate to really our inside knowledge into any of the other segments.

Okay.

Understood.

And then I guess this will also make it difficult, but maybe you can answer the second question.

I mean, just as a ballpark estimate, I know a lot of your products go through distribution, and it's hard to estimate, but could you say what percent, roughly, of your business goes to consumer today, and maybe what percent, roughly, is exposed to U.S.

consumer or the areas seeing some of this extreme unique weakness in the marketplace?

Well, you know, the U.S.

consumer has been 35% or so of our business, and we don't really know what portion is U.S.

consumers, because a fair amount of product built in Asia and other places really ends up being in U.S., and gets sold to consumer.

Secondly, even though we highlight consumer to be 35% of our business, there are many other applications that have consumer-like characteristics.

Is a battery charger for a cell phone a communication product or a consumer product?

Is a radar detector for an automobile a consumer product, or an automotive product?

Is a radio in a car a consumer product or an automotive product?

So I think these are very overlapping applications, and we are in every single one of those applications.

So if you look at just grand consumer, I think, you're looking at consumer behavior, then consumer is two-thirds of the economy.

Everybody knows that.

And so we really see that kind of effect on our business.

And the U.S.

consumer is fully half of the word's consumptions.

So those are big numbers.

But again, I come back to what I said earlier, despite challenging conditions, if that large of a market segment, our numbers are down slightly.

And you can look at our guidance.

It's starting to now correlate with a lot of the companies who have even less exposure in this segment, which is trying to tell me that some of that sentiment of consumers and corporate executives in the industrial segment and communication segment is starting to filter into the entire thing.

Understood.

No, I think it was helpful to hear your definition or view of consumer, which was causing the weakness.

Thank you.

And we do have another question in the queue.

This comes from Doug Freedman with AmTech Research.

Hi, guys.

Thanks for taking my question.

Some of them have been asked and answered.

But if you can look at the analog attach rate and what is happening with some new entrants into the microcontroller arena where we're seeing more programmable solutions that incorporate integrated analog, can you offer your view there on what you see the outlook and opportunities for Microchip to benefit?

Microchip to benefit in analog?

In building integrated circuits that have both the analog and microcontroller, not just working for analog attach.

90% of Microchip's microcontrollers have analog on them.

So a company could come from outside, just focus on just that segment, and call it something different than a microcontroller, and at a small base could go and could look good for a while.

But Microchip ships close to -- over 700 to $800 million of revenue in microcontrollers, which has a substantial amount of analog on it.

We have -- we have lots of those products in our portfolio, also, and have had them for years.

So is this an area that you expect to be growing, or is it something you're going to focus more energy on?

We don't really make a microcontroller today that doesn't have a substantial analog on it.

Our microcontrollers at Microchip are not pure digital engine microcontrollers.

I don't believe we have made any microcontrollers in the last several years, and over 90% of Microchip's microcontroller portfolio, and probably over 85, 90% of our revenue in microcontrollers, are microcontrollers with substantial analog on it.

Rather than system on a chip, I call them system on a PIC.

Okay.

(multiple speakers) to many of the customers, we refer to those PIC microcontrollers as system on a PIC, because they have all the required analog on it, also.

I think that's partially, also, we find at customers where -- when Microchip goes with a microcontroller seeking design, many times the analog on a customer ends up using it on our microcontroller, and therefore we may not win that analog circuit.

But if the customer was using somebody else's microcontroller, maybe didn't have as much analog, was purely a digital, then you could find an analog part from Linear, Maxim, or TI or somewhere.

I think part of our analog challenge is really driven by that most of our analog IT is also available integrated with our microcontrollers.

So therefore every time we go, if the customer needs a microcontroller and an analog, the analog gets cut out, because we bundle it with a microcontroller.

Does that make sense to you?

Yes, absolutely.

As a result of that, do you think that that's part of the opportunity that you have in terms of seeing sort of a higher ASP per system?

And is there more of a trend to incorporate more analog going forward to get more system on PIC?

I think we're -- Ganesh, you want to comment on that?

That's what we've been doing for years.

It is what we've been for a long time.

If you look at our product line progression, the complexity of analog that we have integrated has just gone up over times.

And clearly some of the reasons why we get the gross margins that we get, we get the ASPs that we get, is because of the overall system value we're bringing on these systems on a PIC.

Some of the market share we have gained for years and years in the face of a flat or declining 8-bit market for years, when we were growing and when we were adding value essentially, putting a lot of analog in, improving ASPs.

So it's not something new.

I think that's on the top of the list in terms of what we doing, adding analog and other peripherals on our microcontrollers.

All right.

Excellent.

Changing gears a little bit, can you talk a little bit about your go to market strategy?

I know you've in the past changed your channel strategy from time to time.

Can you give me a summary of how comfortable you are with how it's working right now, and what your view of it is?

Is it something that you're looking at maybe possibly trying to fine tune in any way?

Well, the -- the channel strategy is working well.

Initially, the reaction of some of the channel partners was negative based on us lowering gross margin and taking some of that, and putting that into demand creation effort.

And some of that was misunderstood by some of the channel partners thinking that Microchip will take all that business direct.

And after two years plus, two to four years, depending on which phase of that program you talk about, where we started it four years ago, our market share gains have continued.

Last year was a record gain of market share.

Channel partners have reengaged because Microchip didn't take all their business direct, and they thought --.

Our business from distribution is still very similar, almost 65% that we had four or five years ago.

So I think, there's always room for improvement in getting more effort from all of your channel partners, no matter where they are.

And usually nobody is ever satisfied, because in this business, you have to ask for more, and we'll continue to do so.

But there's really no -- the channel partners are not broken.

Those relationships are not broke.

All right.

Great.

Thank you for your time.

You're welcome.

At this time we have no further questions in the queue.

I will turn it back over to Mr.

Sanghi for any additional or closing remarks.

Thank you very much, everybody, for attending.

We will see some of you on the road as we travel to various conferences and explain our market position further, and I will talk to you in the next conference call.

Bye-bye.

And once again, this does conclude today's call.

Thank you for joining us, and have a great day.